Cash Management

Weighing Your Next Move

Rock-bottom interest rates and new regulation call for a reexamination of short-term cash investments.

Moving corporate cash to boost returns by a basis point or two could earn a CFO or treasurer a well-deserved dressing-down. But that doesn’t mean that finance executives who manage growing pools of idle cash can stand pat with their current investing strategies. Safety and liquidity require constant vigilance — maybe even more so this year.

Big changes on the regulatory front, for example, could affect the returns of money-market funds and create opportunities for corporate investors to earn a bump in yield. And the Fed’s market support is slowly ending, which may force companies to reposition money to maintain a government guarantee on cash accounts.

In a climate of historically low interest rates and fresh memories of the financial crisis, however, making any sort of change to your cash-management strategy can seem downright heretical. “My concern is that an investment is safe and liquid,” says Katy Murray, finance chief of Taleo, a talent-management software firm that generated $50 million in cash last year. “The interest income off of cash hardly moves the needle anymore.”

Money-market funds are Taleo’s instrument of choice, and in fact they are one of the few areas of investment that have been largely rehabilitated. Since the collapse of the Reserve Primary Fund in September 2008, money funds have partially regained their reputations as a safe haven for principal preservation.

Money funds suit treasurers who don’t want the hassle of doing instrument-level credit research and administration, says Peter Yi, director of money markets in the fixed-income group at Northern Trust. Further, “although you do get competitive yield, you also get liquidity the same day.” As of mid-April, however, that competitive yield averaged less than 0.1%.

While liquidity plus a marginal gain brings some comfort, treasurers still need to perform due diligence on money-market funds and monitor them as frequently as weekly, says Matt Clay, head of commingled funds at Clearwater Analytics, maker of a portfolio reporting tool. Clearwater’s clients, for example, dig into a fund’s asset mix, portfolio duration, and credit exposure to the fund’s parent or guarantor.

The Securities and Exchange Commission’s new 2a-7 rules could help here. Starting October 7, money-market funds will have to disclose portfolio holdings on their Websites. They will also have to file a form on Edgar that gives the market-based values of each security and the entire fund.

Investors are pulling out of money-market funds en masse.

That will be useful, because there is still a big difference in risk across the money-fund universe, says Lance Pan, director of investment research at Capital Advisors Group. “In theory, all of these funds would have been scrubbed and scrubbed again,” Pan says. “But we see big disparities.” Some funds have reduced the weighted average life of their investments to 12 days (the maximum allowed is 120), for example, and others are overweighted, perhaps unadvisedly, in things like municipal securities and repurchase agreements.

Ken Grogan, manager of treasury services at Wakefern Food Corp., a cooperative of companies that own and operate ShopRite supermarkets, says Wakefern’s money-market investments are highly diversified, both among fund types and fund families. “Look at what happened with the Reserve Primary Fund,” Grogan notes. “When the Primary Fund broke the buck [dropped below $1 per share], there was a run on the Reserve U.S. Government Fund and it became illiquid.”

Performance outliers among money funds also deserve a close look, says William Dombek, a managing director in The Bank of New York Mellon’s financial markets and treasury services division. If a fund is outperforming the market by 10 or more basis points, says Dombek, “that’s a negative. There is a perception they are pushing the envelope for risk.”

At the same time, the SEC’s new 2a-7 rules potentially make money markets less rewarding. For example, money funds now have to hold 10% of their portfolio in instruments maturing overnight and, beginning later this month, 30% in investments maturing within seven days. Requirements like that could cost the average prime money fund 12 to 15 basis points in yield when the investment environment returns to more-historical rates. In other words, investors won’t earn the same spread over Treasuries as in the past, Pan says. “The rules will bolster liquidity and strengthen stability, but will come with a lower yield,” says Clearwater’s Clay.

Given that possibility, treasurers may have to run just to stay in place. That’s causing renewed interest in other investment vehicles. For the last year, finance departments “were not interested in hearing anything we had to say about anything even remotely pressing the envelope of risk,” Dombek says. “They were confident being judged by their liquidity and risk profiles.”

Tired of earning nothing, however, some finance departments are raising the yield question once again. “Treasurers are still carefully evaluating things from a risk perspective, but they are starting to say, ‘Let’s do the math,’” Dombek says.

Below are some vehicles and strategies that CFOs could consider:

Going Long

“Until we see some rise in the short end of the curve, it’s probably not wise to buy even a 6- or 12-month CD,” says Jeff Flynn, director of the Institute of Public Investment Management. “You’d be locking in the lowest yields we’ve ever seen.”

But to pick up basis points, some companies are venturing at least a little further out. Clients that hold reserve balances on their corporate bonds at BNY Mellon, for example, are structuring portfolios that have a duration longer than 30 days. “They are reaching for duration, but it’s from a total portfolio view,” says Dombek.

The new rule requiring money-market funds to keep a weighted average maturity of 60 days or less will slacken demand for longer-dated securities, possibly resulting in a steeper yield curve, Pan says. So a government agency discount note that matures later than 60 days could soon provide a better return.

Similarly, floating-rate notes — bonds with a short-term variable-rate coupon that resets periodically — may also yield more because of a sell-off by money-market funds. (Money markets can no longer use the reset date as the final maturity.) “Floaters” also provide protection in a rising rate environment.

It bears repeating that reaching too far on the yield curve can be a dangerous strategy, says Marc Peffer, chief investment officer at Milestone Capital Management. “[Interest] rates have nowhere to go but up. If you invest in a longer-dated security, the price of that security will be less than what you paid for it.”

Corporate Havens

Want protection against higher government leverage and government issuer headline risk? Corporate credit could be the new safe haven, Pan says. While it’s unusual, sovereign defaults could lead to more downgrades of national governments, elevating the quality of corporate debt above its home country, particularly in Europe. That phenomenon is known as “piercing the country ceiling.”

While government paper is traditionally viewed as safer, Dombek suggests that on the short end there is too much money chasing too little debt, driving yields lower. And buying debt outside the United States is no longer a slam dunk. “The necessary sovereign risk analysis is significantly greater than it used to be,” he says.

Dombek’s clients are now more interested in commercial paper from big-name companies. The issuances have to be large and regular, though, to avoid poor liquidity out of the gate. Investors eschew owning a large percentage of a company’s outstanding debt, he explains. But commercial-paper rates are also at historic lows — running at 13 basis points for one-month maturities as of February.

Government Backing

For CFOs who want yield but in a near-riskless profile, extended Federal Deposit Insurance Corp. insurance products like the Certificate of Deposit Account Registry Service (CDARS) and Insured Cash Shelter Accounts (ICSAs) offer an alternative. These products split up FDIC-insured bank accounts into smaller pieces across multiple banks, so that the institutional account holder gets insurance coverage above the $250,000 FDIC account limit. CDARS picked up about 1,000 new members in 2008 when midrange banks started to fail, says Phil Battey, a vice president at the Promontory Interfinancial Network.

More CFOs may use these products as the FDIC’s Transaction Account Guarantee Program — which insures non-interest-bearing transaction accounts — expires at the end of June. About $834 billion was parked in those accounts as of the end of 2009. “We love the security” of the CDARS and ICSA products, Wakefern’s Grogan says. “In this market the yield [currently 0.6% to 1.2%] is very competitive.” Grogan prefers the ICSA because of its next-day liquidity.

While money-market funds make sense for stretched treasury staffs, a portfolio tailored to a company’s needs gives it much more transparency and greater control over its investments, Clay says. “If you don’t need 30% [in seven-day] liquidity, why tie up the money in a money market?”

But during the credit crisis, some CFOs found the risk exposure in so-called managed accounts hard to bear, Pan says. The average institutional investor reduced its allocation to managed accounts from 27% to 18% between 2006 and 2009, and many liquidated their holdings at depressed valuations.

Watchful Waiting

Certainly, treasurers and CFOs like the current market climate in that the danger of losing principal appears to be dwindling, and boards of directors are not “beating anyone up [for not producing] yield,” says Grogan. From one perspective, treasurers can only hope that trend continues.

But earning nothing on idle money can grate on CFOs. The futures markets are predicting only a 48% chance that the Federal Open Market Committee will raise the Fed Funds rate in September. For most of 2010, then, the opportunity cost of forsaking extra yield will remain low. But so will the prospects of earning any decent returns on excess cash.

Vincent Ryan is senior editor for capital markets at CFO.